What is an annuity?
In the context of retirement planning, a lifetime annuity is one way of taking benefits from a pension plan. As the name suggests an individual receives an income paid for life at least annually from either the company they worked for or from an insurance company. The annuity market suffered a severe downturn when the government introduced Pensions Freedoms which allowed individuals to access their pensions without any limit on the benefits they take. Pensions Freedoms raised awareness of how people take their retirement income and made many individuals shop around for a better annuity than their existing provider was offering or take benefits using the new rules.
Annuities from work-based pension schemes
Defined contribution money purchase occupational schemes must offer the option of a lifetime annuity, with a scheme pension as a possible option if the individual member refuses the option of an annuity.
Defined benefit final salary occupational pension schemes must offer scheme pensions directly from the assets of the scheme, these can be provided through an insurance company.
Annuities from personal pension arrangements
Where an individual has personal pension benefits, an annuity can be purchased on the open market or can be purchased from the existing provider who also provides the pension plan.
Often referred to as a lifetime annuity or secured pension, a lifetime annuity is a contract between an individual and an insurance company. An individual exchanges a lump sum for a regular income. The insurance company converts the lump sum into an income and promises to pay a set amount of money (the annuity) at regular intervals (at least annually) while the annuitant (the person whose life the contract depends on) is alive.
Is the income protected against inflation?
It is possible to add indexation options to annuities to ensure that the income paid maintains its buying power as time goes on. Adding this benefit comes at an additional cost and will reduce the income paid from the outset.
Am I taxed on this income?
Just as the pension company credited basic rate tax relief when pension contributions were made, the company paying the annuity takes off basic rate tax from the annuity payments made.
I have heard if I am in poor health I can get better terms, is this true?
An individual in poor health may receive an increased income as opposed to an application from someone in better health; it is possible to look at two different types of annuity:
- Enhanced annuities. This kind of annuity offers better rates for individuals who are deemed to have a lifestyle that may increase the chance of early death; examples would include smokers, individuals who are obese and people with diabetes.
- Impaired life annuities. This annuity provides better rates for those applicants who are underwritten and deemed to be in particularly poor health and likely to die within a relatively short period of time.
What if I die early on in the contract?
When an individual dies in receipt of an annuity there are a number of options to retain value in the contract for any surviving beneficiaries:
- Guarantee periods. It is possible to apply a guarantee to an annuity this means the income will continue to be paid to the intended beneficiaries; this guarantee period can last no longer than 10 years from the date of policy inception. The guaranteed payments are taxable in the hands of the recipient.
- Annuity protection. This allows the person taking out the annuity to protect the value of the money they paid to buy the annuity in the first place. A lump sum can be paid on death to intended beneficiaries; the lump sum is calculated as the difference between the price paid for the annuity less the payments already paid. The lump sum paid is taxable in the hands of the recipient.
Can I change my mind if annuity rates improve?
Once in payment, it is currently not possible to renegotiate the terms of the annuity contract. When considering how to take the taxable part of pension contract it is vitally important to look at all the available options. It is important to seek independent advice before making a final decision.
This is subject to change as the government are currently in consultation to open a Secondary Annuity Market in April 2017. This is yet to be finalised but the plan is to make it possible for existing annuities to be sold on an open market for a cash sum.
Advice and Recommendation
With a changing global demographic, Europe’s increasing influence on solvency and the UK life offices, life expectancy increasing and governments in turmoil pushing annuity rates lower, advice in this area has never been more important. If a secured lifetime income via an annuity is the right decision for you, then we can certainly offer advice and recommend exactly which option or combination of options would provide for maximum benefits.